New Zealand’s financial system resilient

The Reserve Bank today released its
Financial Stability
Report, a twice-yearly report assessing the health of the New Zealand
financial system.

Reserve Bank Governor Alan Bollard said the financial system is sound and has
been reasonably resilient against a back-drop of worldwide market volatility.

"In recent months global financial stability has been severely tested,
with turmoil in financial markets," said Dr Bollard. "Failure by
borrowers in the US sub-prime mortgage market to meet their payments led to more
widespread financial market volatility. As a result, the cost of risk has
increased and liquidity has reduced."

Liquidity in the New Zealand dollar foreign exchange and interbank markets
was tightly stretched in August, and, like many other central banks, the Reserve
Bank stepped in to ensure the interbank market could trade normally.

"Recent events highlight the importance of liquidity for institutions
and the financial system as a whole, and there are important lessons to be
learned," Dr Bollard said. "New Zealand is heavily reliant on
foreign capital markets, given its large external debt. These markets may not
be as secure and liquid as previously thought."

Dr Bollard said the Reserve Bank is commencing work on a specific liquidity
policy for banks, which it expects to introduce in 2008.

Reserve Bank Deputy Governor, Grant Spencer, said banks' asset quality
remains in good shape, and profits continue to increase in line with growth in
bank lending. However, risks to financial stability still remain due to low
household saving. Debt and debt-service ratios continue to rise, making
households and the financial sector vulnerable to a housing market correction.

Mr Spencer said failures in the non-bank financial sector to date have been
caused by underlying solvency problems related to asset quality, connected
lending, and credit management. However, recent liquidity pressures have been a
trigger for closure in some cases, and many companies are under continued
liquidity pressure because of reduced deposits by households.

"Despite the substantial impact of recent events on non-bank
depositors, the failures are unlikely to have broader negative effects on the
financial system and the economy," Mr Spencer concluded.

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